January 29, 2022

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Elements of costs: Prime costs and Overheads

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Costs are usually incurred in the normal day to day business activities. In any business type, some costs are closely related to making a particular product. This is called direct costs. Other costs are not far off from the product referred to as indirect cost.

However, the cost can further be classified as prime costs and overhead costs. While prime costs related with direct costs, overheads are mostly called indirect. In manufacturing businesses, costs are mostly classified as prime costs and overheads.

What is Prime Cost?

Prime costs are all direct material, direct labour and direct expenses costs. In a null shell, prime costs are direct costs.

Prime cost formula

The formula for the prime cost is stated below:

The sum total of the aforementioned are prime costs.

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Direct Material Cost: These are the cost of materials and ingredients used up in the production of goods or the rendering of service. It is computed as follows:

Direct Labour Cost: These are the number of wages paid to employees and contract staff who are directly involved in the production of the goods or the rendering of the service. This has been explained in detail in an earlier article.

Direct Expenses: Expenses incurred that have considerable effects and can be traced to the production of the goods and the rendering of service is a direct cost. Royalty fee is a perfect example, rent or lease of special plants or equipment, etc.

Overheads

Overheads costs are all indirect expenses. These expenses are required in running the day to day business activities of the firm but are not related to a single product of the firm. These costs are subdivided into the following:

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Factory Overheads: This relates only to manufacturing companies. It is the costs incurred during manufacturing processes but not traceable to a product.

Examples of factory overheads are fuel for generator, depreciation of plants, salary paid to factory supervisor, insurance of factory plants and machinery.

Non-Factory overheads: These are overheads that do not relate to the factory nor the production of goods. It is divided into two parts. Administrative Overheads, Distribution and selling overheads.

Administrative overheads relate to salaries of office assistants and others who are not working in the factory nor involved in the selling and distribution of goods or services. Rent of admin office, depreciation of managers’ motor cars, general insurance, office electricity bills and so on.

Selling and Distribution Overheads are expenses for distributing the goods to customers. depreciation of delivery van, salaries of sales representatives, loss allowances (bad debts) and its provisions are examples.

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Certain overheads are a single expense. For example, electricity bills. However, management will decide how to apportion these types of expenses among the two types of overheads.

With this, we are done with the classification of cost according to its elements. In the next article, classification of costs according to behaviour will be explained.

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